The People’s Bank of China announced on Friday a cut in its Reserve Requirement Ratio (RRR) of 50 basis points for eligible financial institutions starting on July 15 to support the real economy.
As had been picked up in the press, Premier Li Keqiang at a State Council executive meeting on Wednesday called for a timely cut to the RRR for banks to support the real economy, but he also warned officials to avoid “flood-like stimulus” and to keep monetary policy stable.
After the meeting, China’s top financial officials met and decided to announce an RRR cut of 50 basis points on Friday. The message Beijing is now seeking to convey is that the move does not mean that China’s economic growth has lost momentum, and indeed one of these officials states that he is sure that China’s GDP will keep above 8% year on year in Q2.

Didi’s decision to go public in the US was made without consulting the Cyberspace Administration of China and the Ministry of Public Security and does not conform to the position of the Central government. Even if Didi continues to list in the US, its domestic business will suffer a huge contraction. As far as I know, about 20 central ministries and commissions, including the PBoC and CBIRC, have decided in the last two days to ban their staff from using Didi during official duties. If Ant group’s plans to list in Hong Kong and Shanghai were just a mistake, Didi’s IPO is [an] extremely black deed.

** But the ECB’s 2023 forecast next spring is still expected to show a small undershoot of its 2% target (a “symmetrical target,” they will note after the final phrasing is formalized for the Strategy Review in September. The ECB will not adopt a more rigid average inflation regime). The ECB will thus seek to avoid a cliff effect from that 40 billion euros PEPP purchase pace in April of 2022 when it comes to an end. To keep inflation expectations from falling back down, the ECB would then top up its Asset Purchase Program by perhaps 20 or 30 billion euros, depending on conditions at that time, to ensure a smoother step down from a combined total of 60 billion to around 40-50 billion euros of APP-only bond purchases a month.
This is just a suggested scenario, but we do take note when people close to the decision-making process lay out hypotheticals, especially when they seem so eminently reasonable.

Altogether this argues for the dots to edge higher in 2022 and 2023 such that the median FOMC participant anticipates a rate hike in 2023. I think any reasonable forecast likely has the economy meeting the Fed’s employment and inflation objectives as early as the end of 2022 and as such it doesn’t seem particularly credible within the context of the new framework to not expect a rate hike in 2023.

*** Our understanding is that at a State Council Executive Meeting held in Zhongnanhai on Wednesday morning, Beijing time, Premier Li Keqiang said that while China now imposes a 25 percent general corporate tax rate (with exemptions for a few industries such as semiconductors), which is higher than the proposed minimum global corporate tax rate, we (China) are inclined to endorse the G7’s minimum global corporate tax deal at the G20 Finance Ministers and Central Bank Governors Meeting that will be held in Venice on July 9-10th. ***

...The EU and US will also commit to putting an end before July 11 to the long -standing conflict over aircraft subsidies in the Boeing-Airbus wars, and in doing so will prevent an escalation of the retaliatory measures that the EU has warned it could impose under WTO rulings should there be no deal by that date...

...The Russia Nord Stream Angle

Biden seems to have won Berlin over into a more robust stance against China in large part through bribery — by giving up on his initial promise to block the completion of the Nord Stream 2 gas pipeline that is set to provide cheap Russian gas to Germany.

Controversial in both the US and EU, the government of Chancellor Angela Merkel had been fighting tooth and nail to complete that project, over objections that the pipeline will increase Europe’s dependence on fossil fuels, on Russia for energy supplies, with all the security implications involved, and in the process weaken Ukraine as a transit country for the existing Russian gas pipeline.

China’s retaliatory measures against EU officials over criticism of its human rights, which led to the suspension of the EU-China Comprehensive Agreement on Investment in the European Parliament, did help to play into US hands – indeed, even before swearing in on January 20, 2021, the incoming Biden administration had sent informal signals to the EU in late 2020 to refrain from signing the CAI before consulting with the US.

There is some speculation now that Biden will also use the dropping of White House opposition to the Nord Stream 2 pipeline when he meets on Wednesday in Geneva with Russia’s President Vladimir Putin as a reminder of America’s clout and of potential rewards that could come to Russia through better relations with the US.

While the Nord Stream compromise might serve on the margins to soften an otherwise ice-cold bilateral relationship between Moscow and Washington, whether it does much more than that will remain to be seen.

** In addition to a global minimum tax, and indeed as a condition of that agreement with the United States, the G7 also struck a deal on the even thornier issue of a cross-border digital tax, agreeing in its communique that the largest and most profitable multinational digital firms [read Google, Amazon, Facebook, Apple, Microsoft, etc.] will have to pay [some] tax in the countries where they operate, not just in their tax-based domiciles.

The G7 will commit to “properly embed” climate change and biodiversity loss in economic policymaking and will use carbon pricing as a policy lever. Central banks, and supervisory agencies, are to treat risks posed by climate change as financial risks.

The G7 will agree that the global financing system needs to be “greened” to better price climate risks and will call for mandatory climate related financial disclosures from companies to help markets value shares accordingly.

To avoid many different standards around the world for what constitutes a “green” or “sustainable” investment, the G7 will pledge to work among themselves and with other international partners towards one common line.

Liu He’s Opening Comments:
The extraordinary quantitative easing and huge stimulus package of the US are creating a new round of global inflation and asset bubbles, which are likely to cause sharp turmoil in global financial markets over the rest of the year. If that is so, it will have a negative impact on China’s economic growth, as well as on the RMB (renminbi), domestic stock, and bond markets.
I therefore decided to hold the FSDC meeting [to deliver] a strong warning. The most important topic of the meeting is to strengthen risk management and prevent financial risks. We have made risk management a priority for the financial services industry and the country. It will help reduce or avoid negative outcomes while building a solid foundation for rapid and continued growth.

The meeting warned of shocks overseas, and sought to deal with imported inflation, and to enhance expectations management with well-prepared policies. We noted that much more aggressive fiscal stimulus and strong economic recovery expectations in the US have resulted in rising inflation and have boosted global asset prices, triggered more capital flows to the US from emerging markets, and increased debt risks in emerging economies. We should pay attention to the changes in monetary policy in emerging economies, which may result in a short-term impact on our financial system.

Lest there be any questions as to the seriousness of Beijing’s efforts and its intentions, a very senior official source had this to say after the ban:
There is no doubt that this time we have cracked down on encrypted virtual currency more severely than in September 2019, and the price of virtual currency will be hit even harder than last time. We must provide an absolutely safe financial environment for the pilot and promotion of the digital RMB in China [our emphasis added].

EU officials say in private that the 15% rate is likely to be good enough for Luxembourg, Ireland, and other EU tax havens. There is a very strong expectation that the G20 will reach an agreement in principle on that 15% global minimum tax rate during the G20 finance ministers and central bank governors’ meeting in Venice in the first days of July.

Falling sales, weak starts, and rising prices are all consistent with a market where demand has pushed supply to the limit. On the existing home side of the ledger, limited inventory is holding back sales and pushing up prices. Higher prices will push lower-income purchasers out of the market while, in theory, inducing some homeowners to sell. But if you sell your house, you have a problem – finding a new one. Also in theory, builders could bring new product to the market, but in practice right now builders are constrained by high materials costs (although lumber has come down off its highs), labor shortages, and lot shortages.

The housing situation is analogous to the current automobile market. This is the best time to sell a used car, but not so great for buying a new car. Automakers are also struggling with rising costs and, most importantly, a chip shortage that severely limits new production:

In both cases, we should expect the end result of slower sales in the near term as, hopefully, the supply situation adjusts. Some commentators will suggest that slower sales signal softening demand, but don’t be fooled. It’s the supply constraints in both cases that limit growth. It can’t be “solved” with easier monetary or fiscal policy. That said, it could press the Biden administration to push an even faster reopening of the economy.

If this goes sideways, it will because we didn’t challenge the conventional wisdom. The Fed is not ready to challenge the conventional wisdom. It is far too early in the process to think the Fed will back down from its current position. It is more likely that it hangs onto its current position even tighter if evidence mounts that challenges the conventional wisdom. Fed officials are deeply committed to returning the labor market to its pre-pandemic full employment conditions. I think the Fed’s tolerance for inflation will rise before it shifts its employment goals. It is hard for me to see it can make another choice and I can already see that happening. Last week, Federal Reserve Governor Christopher Waller said steady, above 4% inflation was the redline. That’s a surprisingly high redline; there is a lot of room between here and there and, importantly, that room is just elevated inflation, not hyperinflation. If it was hyperinflation, the Fed would be quick to act. If it’s a continuous but modest tug upward, the Fed will be quick to dismiss. That’s probably how you back yourself into a higher-inflation environment.

Senior Chinese sources hope the talks may be held by the end of this month. Furthermore, our understanding is that media reports that Vice-Premier Hu Chunhua has replaced the elderly but still extremely highly respected Vice-Premier Liu He as the top Sino-US trade negotiator are false, and that these negotiations are still being led by Liu.

Bottom Line: Fed speakers continue to yield no ground, leaving me unable to change my expectations about the path of policy. The data flow, however, makes the risks to the Fed’s position look increasingly one-sided. A modest April inflation number would give the Fed some room to breathe whereas a hot print will push hard against its narrative, but it won’t drop that narrative easily.

Correcting High-Tech Monopolistic Behaviors

** An important policy support to ensure a strong domestic high-tech sector, President Xi praised the big three Chinese tech companies. Alibaba, Baidu and Tencent as “the pride of the Chinese people” and committed the government to support their further development.

** But to correct a disorderly and uncontrolled expansion of the high tech sector, the government will seek to establish a comprehensive set of rules to strengthen its supervision of financial activities on internet platforms to “help correct monopolistic behaviors.”

** In order to strengthen anti-monopoly measures and to prevent uncontrolled capital expansion, ten government departments, include the NDRC, the Peoples Bank of China and the State Administration for Market Regulation have begun coordinated work to update antimonopoly policies with proposals due by September that should “safeguard fair competition” in the market.
Policy validation

There was consternation last Friday when the German constitutional court suspended the signing into law by the German president of the European Union’s “Own Resources Decision” despite its passage by overwhelming majorities in both the Bundestag and the Bundesrat just hours earlier.

** The court’s move was in response to a last minute emergency complaint filed by opponents in Germany to the EU’s recovery plan, mainly the far-right Alternative for Germany (AfD) and a group called Citizens’ Will Alliance. They argue in their petition to the Court that the plan violates German law by making the country liable for debts incurred by other EU countries.

** Friday’s suspension is a temporary measure that will probably take no more than a few weeks to be resolved. A full injunction seems very unlikely, while the court may issue a “conditional” ruling allowing the scheme to proceed with safeguards to ensure no violation of the German constitution. But the overwhelming sense is that the constitutional complaint will be dismissed.

Bottom Line: Overall, the message of this FOMC meeting was that the Fed fully intends to follow the new framework when setting policy and will not be pulled into a pre-emptive policy tightening. The forecasts even foreshadowed the expected near-term inflation acceleration, effectively formalizing the stated intention to look through transitory inflation outcomes. The Fed very much intends to let the economy run hot to make up lost ground as quickly as possible. We should not doubt the Fed’s intentions when the first high inflation numbers start coming in but the reality is that this meeting will not be the end of the cat and mouse game between market participants and the Fed. This environment of steady policy in the face of improving economic conditions should remain consistent with a general steeping of the yield curve.

Though a close run thing, we think the 2023 median rate plot will not show a rate hike. It would require five or more of the now 18 FOMC members to join the five who in December had already penciled in one or more hikes in 2023. On balance, we think it unlikely. The linchpin to that more benign rate dot plot outcome, even if markets latch on to any signs of earlier hike expectations by a growing FOMC minority, will be core PCE projections that steadily rise across the forecasting horizon but remain still shy of an inflation overshoot in the 2023 median.